The UAE has implemented a series of economic substance regulations to comply with the requirements set by the Organization for Economic Cooperation and Development (OECD). The regulations require businesses to demonstrate that they have sufficient economic substance in the UAE and to report on their activities to the relevant regulatory authorities. In this blog post, we’ll take a closer look at economic substance regulation reporting in the UAE.
What is Economic Substance Regulation or ESR?
The Economic Substance Regulations, commonly known as the ESR were introduced in the UAE in 2019 to ensure that businesses operating in the country have sufficient economic substance to justify the benefits of being located in the UAE. The regulations apply to all UAE onshore and free zone companies and branch offices of foreign companies that carry out “relevant activities,” which include banking, insurance, finance, leasing, fund management, headquarters, shipping, intellectual property, and holding company businesses.
What is meant by Economic Substance Regulation Testing or Assessment?
Businesses may conduct their own internal assessments or hire third-party firms to conduct independent assessments or audits to ensure that they meet the ECONOMIC SUBSTANCE REGULATION requirements. The assessments typically involve reviewing the business’s corporate structure, governance, management, financials, and operations to determine if the business is compliant with the ECONOMIC SUBSTANCE REGULATION.
The ECONOMIC SUBSTANCE REGULATION testing or assessment process is important for businesses to demonstrate their economic substance in the UAE and to avoid penalties or fines for non-compliance. By ensuring compliance with the ECONOMIC SUBSTANCE REGULATION requirements, businesses can maintain their presence in the UAE and continue to benefit from its favorable business environment.
The ECONOMIC SUBSTANCE REGULATION requires businesses to satisfy three key tests:
- The “core income-generating activities” (CIGA) test: This test requires that the relevant activity is being conducted in the UAE, and the business must be able to demonstrate that it has the necessary personnel, equipment, and premises to carry out its activities.
- The “directed and managed in the UAE” test: This test requires that the business is directed and managed in the UAE, and that its board meetings are held in the UAE.
- The “adequate expenditure and workforce” test: This test requires that the business has an adequate number of qualified employees, an adequate level of expenditure, and that it incurs sufficient operating costs in the UAE.
What are the Reporting Requirements for ECONOMIC SUBSTANCE REGULATION?
All businesses that fall within the scope of the ECONOMIC SUBSTANCE REGULATION are required to submit an annual notification to their regulatory authority, which in most cases will be the relevant free zone or mainland authority. The notification must provide details on the relevant activity carried out by the business and must confirm whether or not the business has met the ECONOMIC SUBSTANCE REGULATION requirements.
In addition to the annual notification, businesses that carry out relevant activities are required to file an economic substance regulation report within 12 months of the end of the financial year. The report must include information on the business’s activities, the number of employees in the UAE, the amount of expenditure incurred in the UAE, and the location of the business’s premises.
The regulatory authority will review the notification and the report to determine whether the business has met the economic substance requirements. If the business is found to have failed the requirements, the regulatory authority may impose penalties, including fines, suspension or revocation of the business’s license, or even criminal sanctions.
What details must be included in the ESR report?
The Economic Substance Report (ESR) requires businesses to provide specific information to demonstrate their compliance with the regulations. The report template consists of the following sections:
General Information: This section requires the licensee’s name, license number, name of the licensing authority, regulatory authority, permanent place of establishment, office location, legal forms, and premises. Additionally, businesses need to answer three questions regarding Value Added Tax registration, multinational group membership, and government ownership.
Branch Details: If a business has branches other than the main office, they must provide their license number and name of the licensing authority in this section. Branch details of one or more branches can be added individually.
Reportable/Financial Period: Businesses need to mention the start and end date of the financial year for which they are reporting in this section. Note that the start and end date of the completed financial year should be mentioned, not the current one.
Updated Information: This section requires businesses to state whether the above questions are different from the notification form they have already submitted. They must provide a reason if they answer “yes”.
Financial and Accounting Information: Businesses need to provide their total revenue, accounting profits or losses, and net value of UAE assets in this section. They must also answer two questions related to audited financial statements and currency used in financial statements.
Provide Information on Relevant Business Activities: In this section, the economic substance report template presents a list of relevant activities, from which you are required to select one or more activities that your business performed during the reportable financial year. You will need to specify the relevant authorities and activities and answer the following questions:
- Whether or not your business is considered a high-risk intellectual property business.
- Whether or not any outsourced service providers were hired for any of the relevant activities.
You will then need to provide detailed information on the relevant activities you selected.
Provide Information on Business Ownership: This section requires you to provide the name of the parent company, its tax identification number, complete address, and tax residence country. The same information is required for the ultimate parent company and ultimate beneficial owner. If your business worked with outsourcing providers, you will also need to provide similar information for them.
Provide Information on Business Management in the UAE: In this section, you will need to provide details on how your business was managed in the UAE during the reportable financial year. This will involve justifying the details of board meetings held inside or outside the UAE, decisions of the meetings, and minutes of the meetings.
Declarations: This section requires you to confirm that you have adequate physical assets, sufficient expenditure, and the required number of qualified employees. Additionally, you may attach additional documents along with the mandatory financial statements.
Preview Your Form: After ensuring the accuracy of the information provided in the form, you can preview it for a final review before submitting it.
How to Ensure Compliance with ECONOMIC SUBSTANCE REGULATION?
To ensure compliance with the ECONOMIC SUBSTANCE REGULATION, businesses should take the following steps:
- Identify whether the business falls within the scope of the ECONOMIC SUBSTANCE REGULATION.
- Conduct an assessment of the business’s economic substance in the UAE.
- Take steps to ensure that the business satisfies the three key tests of the ECONOMIC SUBSTANCE REGULATION.
- Maintain proper records and documentation to support compliance.
- Prepare and submit the annual notification and economic substance regulation report to the relevant regulatory authority.
The Economic Substance Regulations in the UAE are designed to ensure that businesses operating in the country have sufficient economic substance to justify the benefits of being located in the UAE. Compliance with the ECONOMIC SUBSTANCE REGULATION is critical for businesses that carry out relevant activities in the UAE, as failure to comply can result in significant penalties. By taking the necessary steps to ensure compliance with the ECONOMIC SUBSTANCE REGULATION, businesses can avoid penalties and continue to operate successfully in the UAE.